China Tightens Oversight of Trusts as Default Risk Rises

April 14 (Bloomberg) -- China’s banking regulator ordered
owners of the nation’s 68 trust companies to be prepared to
provide funding or sell their stakes as the risk of defaults
rises in the $1.9 trillion industry for high-yield investment.

The China Banking Regulatory Commission told trust
companies to either restrict their businesses and reduce net
assets or have shareholders replenish capital when the firms
suffer losses, according to an April 8 notice that was seen by
Bloomberg News. The regulator will also impose a “strict”
approval process on trust firms’ entry into new businesses and
products starting this year, according to the document.

China is stepping up regulation of the industry after the
nation in January avoided what would have been its first trust
default in at least a decade. About 5.3 trillion yuan ($853
billion) of products are due to mature this year, up from 3.5
trillion yuan in 2013, Haitong Securities Co. estimated in a
January report, warning that firms can no longer shoulder all
the risk tied to implicit guarantees associated with the trusts.

“We will see a peaking of trust-product maturity in the
second quarter, so it’s very timely to have more regulation in
place,” Huang Wentao, a Beijing-based analyst at China
Securities Co., said by phone. “The central government is
committed to rein in any risks before they turn into a systemic
crisis.”

Full Disclosure

The banking regulator indicated in the notice that the
statement was being distributed to all CBRC branches and trust
companies that it oversees. The CBRC also banned individuals
from using money that’s not their own to purchase trust
products, which typically require a minimum investment of 3
million yuan. The regulator urged trust companies to fully
disclose risks during their sales process and move toward using
tape or video recordings to keep records.

By offering better returns than bank deposits, trusts have
gained popularity among China’s wealthy investors and overtaken
insurance to become the biggest segment by assets of the
country’s financial industry after banks. Trust assets surged
more than fourfold from the beginning of 2010 even as policy
makers sought to curb money flows outside the formal banking
system.

The industry’s growth makes more investors vulnerable to
losses as China’s slowing economy makes it more difficult for
borrowers to repay their debt.

At least 20 trust products have run into difficulty making
payments since 2012, according to Beijing-based China
Securities. All have avoided default as issuers or third parties
such as state-owned bad-loan managers and guarantee firms
eventually repaid investors in full.

Missed Payments

Investors in a 3-billion-yuan trust product issued by China
Credit Trust Co. and distributed by Industrial & Commercial Bank
of China Ltd. to fund a coal miner were bailed out by an
unidentified person or group days before its maturity in
January. Last month, Jilin Province Trust Co. missed payments on
a 973-million-yuan product as Shanxi Liansheng Energy Co., the
borrower drawing on the trust’s funds, underwent a local
government-led plan to restore profitability.

The CBRC told its local branches to monitor risks in areas
including local government financing vehicles, real estate,
mining and industries with excessive capacity, according to the
document from the regulator.

Trust companies should establish a mechanism to deal with
crises, including delaying executives’ incentive compensation,
restricting dividend payouts and disposing some businesses. The
regulator is also studying the establishment of a trust
stability fund to avoid systemic shock from the failure of any
institutions, according to the document.

Trust firms should also submit by June 30 plans to unwind
pools of non-tradable assets managed by the companies, a
business that had “shadow-banking characteristics,” the CBRC
said. Any newly issued products need to be reported to the
banking regulator 10 days before sale, it said.